Nutrient Trading – A Water Quali by dudu520

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									                OECD WORKSHOP ON
              AGRICULTURE AND WATER:
        SUSTAINABILITY, MARKETS AND POLICIES
                                14-18 November, 2005:

                   14-16 November – Adelaide Convention Centre,
                       North Terrace, Adelaide, South Australia

                     17-18 November – Barmera, South Australia


                                   SESSION N°2
                Nutrient Trading – A Water Quality Solution?

                            Dr Suzie Greenhalgh and Mindy Selman

                                    World Resources Institute




Information on the Workshop is accessible though the OECD Password Protected website at:
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Nutrient Trading – A Water Quality Solution?
Dr Suzie Greenhalgh and Mindy Selman
World Resources Institute


Abstract
The over-enrichment of rivers and estuaries by excessive levels of nutrients, such as nitrogen and
phosphorus, is a persistent and growing water quality problem around the world. Even though there have
been significant improvements in water quality, most of these improvements have resulted from regulating
point sources- industrial and municipal wastewater treatment facilities; today the predominant source of
nutrients is non-point sources, especially agricultural and urban runoff.

Innovative solutions are needed to provide incentives for non-point sources, whose nutrient discharges are
difficult to regulate, to reduce their nutrient contributions. One such solution is nutrient trading. Trading
involves setting a goal for the total amount of nutrients entering streams and rivers within a watershed and
allowing sources, both point and non-point, to trade nutrient reduction credits in order to meet the local
and regional water quality goals.

Nutrient trading is being explored and implemented as a viable mechanism to reduce nutrient pollution in
a number of areas in the US and internationally. To facilitate the establishment of these markets, we have
developed an on-line marketplace, NutrientNet, for point and non-point sources to estimate their nutrient
loads and achievable reductions, provide a marketplace for trades to occur and a registry that allows trades
to be tracked.

Keywords: nutrient trading, cost-effective, policy, performance-based instruments, water quality,
agriculture.

Setting the Scene

Water quality is rapidly becoming one of the most pressing environmental concerns facing many parts of
the world today. In the U.S. alone 39 percent of assessed U.S. rivers and streams, 45 percent of assessed
lakes, reservoirs and ponds, and 51 percent of assessed estuaries were threatened or impaired for their
designated uses in 2000 (USEPA, 2002).

Nutrient over-enrichment—one of the leading causes of water quality impairments in the U.S.—has led to
the eutrophication of many of the nation‟s rivers and streams, and to the formation of hypoxic zones in the
Gulf of Mexico and the Chesapeake Bay. A majority of these nutrients come from non-point sources,
principally agricultural sources. Approximately 82 percent of the nitrogen and 84 percent of the
phosphorous in U.S. lakes, rivers and estuaries come from non-point sources (Carpenter et al., 1998). The
nutrient pollution from non-point sources, such as agricultural or urban runoff, is typically diffuse in
nature. Its precise origin cannot be identified, and because of this, non-point sources are frequently not
regulated. The other source of nutrients is point sources, such as wastewater treatment facilities. Point
source pollutants can be pinpointed to a specific source of origin, e.g., discharge from a pipe into a
waterbody, and therefore are typically regulated.




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This paper takes a closer look at policy instruments to improve water quality, comparing the traditional
command-and-control approaches to the more innovative performance-based instruments. Given the
apparent cost-effectiveness of performance-based instruments, it goes on to outline some of the challenges
and issues with establishing successful nutrient trading programs, one type of performance-based
instrument. Finally, the paper describes an on-line marketplace, NutrientNet, which we have developed to
facilitate the implementation of these programs. The paper also recognizes some of the significant
synergies between the efforts undertaken to reduce nutrient losses and a number of other environmental
problems, such as climate change and soil erosion, highlighting the need to start addressing environmental
problems more holistically.

Policy Approaches for Improving Water Quality

There are a number of policy instruments that can be used to address environmental problems—traditional
policy instruments such as regulations, and taxes and subsides, and the more innovative performance-
based instruments. All of these instruments can be applied directly or indirectly to water quality concerns.

Traditional policy instruments

Regulations
One popular policy instrument for addressing water quality problems (as well as many other
environmental problems) is the use of regulations, also referred to as a command-and-control approach.
Regulations are typically technology-based or performance-based standards aimed at point sources such as
wastewater treatment and industrial facilities. Non-point source pollution—whose source is more difficult
to identify than point-source discharges—cannot be as easily controlled through regulation.

Technology-based standards specify the type of equipment or processes that each facility needs to adopt to
meet a water quality target, while a performance standard specifies a target and gives facilities greater
flexibility in how they meet that target. This is often seen as regulatory limits placed on pollutant
discharge into waterways (e.g., USEPA NPDES program1).

Even though this regulatory approach achieves initial success in improving water quality, it does place
heavy financial burdens on facilities to continually upgrade their equipment, and regulators to keep abreast
of new technological advances, and provides little opportunity or incentive for facilities to be innovative.

In the U.S., between 1974 and 1994, local governments and the federal construction grants program spent
approximately $213 billion for the construction or upgrades of municipal wastewater treatment facilities
to control point-source pollution. During the next 20 years, it was anticipated that an additional $330
billion would likely be required to construct new plants and replace aging facilities to meet the water


1
  The National Pollution Discharge Elimination System (NPDES) program of the U.S. Environmental Protection
Agency (USEPA) sets specific pollutant discharge limits for all point sources discharging into U.S. waters. The
program was developed in 1974 and has been expanded to include dischargers such as large concentrated animal
feeding operations (CAFOs), municipal wastewater treatment facilities, and commercial and industrial facilities.




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quality levels and treatment demands of a growing U.S. population using this policy approach
(Association of Metropolitan Sewage Agencies and the Water Environment Federation, 1999).

Taxes and subsidies
Another set of policy instruments used to address pollution includes taxes and subsidies. Taxes place a
penalty on polluters, providing the „stick‟ in the carrot and stick analogy, while subsidies are the „carrot‟,
providing incentives (usually financial) for polluters to reduce their discharges. These instruments are
often used to provide incentives for non-point sources of pollution. In the U.S., taxes are rarely used in the
agricultural sector to change behaviour while in some OECD countries taxes have been more widely used;
especially where pollution sources can be tied to inputs, such as fertilizers and pesticides, in the production
process. Fertilizer taxes have been introduced in Finland, Norway, and Sweden with this tax revenue
frequently earmarked for various environmental uses. Sweden, for instance, uses its fertilizer and pesticide
tax to finance environmental research and improvements (O‟Riordan, 1997).

Subsidies are common instruments used to provide incentives to implement agricultural best management
practices (BMPs) aimed at providing environmental benefits. In the U.S., some examples include the
Conservation Reserve Program—which pays farmers to take agricultural land out of production—and
subsidies to increase the use of conservation tillage practices on cropland; both are aimed at reducing soil
loss from agricultural land. Subsidies target a prescribed set of practices, rather than allowing farmers to
choose the most effective way for them to address the specific problem at hand.

Performance-based policy instruments

Performance-based policy instruments target an environmental outcome rather than the sources of
pollution and are frequently market-based, i.e., kilograms of nutrient pollution reduced is the commodity
of interest, not the implementation of a BMP that results in a reduction in nutrient losses. Two
performance-based mechanisms that can be applied to improve water quality are nutrient trading and
reverse auctions.

Nutrient trading
Nutrient trading is an example of a performance-based instrument that is gaining popularity as a
mechanism to cost-effectively meet water quality goals. Nutrient trading is premised on the fact that
compliance costs differ between individual industrial and wastewater treatment facilities depending upon
their size, scale, age, and overall efficiency. This means that the cost of meeting a water quality standard
(or regulation) may be less for one facility than for another. Trading between point sources provides an
opportunity for those facilities whose costs are lower to make additional reductions beyond their
obligation, and sell these additional reductions to facilities whose costs are higher.

Similarly, trading can also occur between point sources and non-point sources. Point sources with high
compliance costs can purchase nutrient reduction credits from non-point sources, whose nutrient
reduction costs are much lower. There are many instances where point source facilities are controlled by
regulatory discharge permits (e.g., USEPA NPDES program), while non-point sources are often not
controlled by regulatory limits. Trading gives both point sources and non-point sources the flexibility of
achieving an environmental target using the most cost-effective option available to them. There are a
number of nutrient trading programs currently in operation in North America. The Long Island Sound




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trading program administered by the Connecticut Department of Environmental Protection, for example,
addresses the problem of low oxygen levels in Long Island Sound by trading nitrogen credits between
point sources, which are the main cause of excessive nitrogen levels in the Sound. The South Nation
watershed in Ontario, Canada also has a trading program in operation that targets phosphorus discharged
from both point and non-point sources.

Reverse auctions
Reverse auctions are another example of performance-based policy instruments. They are competitive
bidding systems where sellers compete to supply buyers with a specified good or service, enabling buyers
to locate the most competitive sellers. The key difference between reverse auctions and conventional
auctions is that in reverse auctions sellers bid to sell goods and services at lower prices than their
competitors, whereas in a conventional auction buyers compete with each other to purchase goods and
services from sellers. Thus, in a reverse auction sellers bid prices down while in a conventional auction
buyers bid prices up. Reverse auctions are used in a variety of markets and are particularly suited to
markets with multiple sellers and only a single buyer. The reverse auction concept has been used in the
Conestoga watershed in Pennsylvania, U.S. to purchase phosphorus reductions from farmers. In this
instance, an environmental organization with funding from the U.S. Department of Agriculture (USDA)
acted as the buyer for these reductions.

How Do Performance-Based Mechanisms Compare?

The World Resources Institute has undertaken two analyses to compare a variety of policy instruments for
improving water quality—one addresses the hypoxic zone in the Gulf of Mexico and the other looking at
phosphorus reductions in three watersheds in the Upper Midwest of the U.S.

Analysis of nitrogen water quality impairments

A 2003 study by WRI (Greenhalgh and Sauer, 2003) assessed a variety of agricultural policy options to
mitigate the hypoxic—oxygen depleted—zone in the Gulf of Mexico and found that nutrient trading was
the most cost-effective solution. The hypoxic zone results from excessive amounts of nitrogen entering
the Gulf of Mexico from the Mississippi River (Goolsby et al., 1999). By the summer of 2002 the
hypoxic zone, which has been consistently monitored since 1985, reached a height of 22,000 km2 or
8,500 square miles in size (Rabalais et al., 1999; Dunne, 2002; LUMCON, 2002), A majority of the
nitrogen in the Mississippi River Basin comes from agricultural non-point sources,2 prompting us to
explore several agricultural policy options as a mitigation strategy.

This study compared policy options that directly affected nitrogen losses in the Mississippi River Basin,
as well as a number of options that focused on other environmental problems such as soil loss,
phosphorus runoff and climate change. By comparing a wide range of policies and their impacts, we were
able to look more broadly at the environmental benefits of the various options.


2
 50% of nitrogen reaching the Gulf of Mexico comes from fertilizer and soil organic nitrogen; 24% from
atmospheric deposition, groundwater discharge and soil erosion; 15% from animal wastes; and 11% from municipal
and industrial facilities (Goolsby et al., 1999).




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The policy options assessed included:
    Taxing nitrogen fertilizer applications,
    Subsidizing a change to conservation tillage practices,
    Extending Conservation Reserve Program (CRP) acreage,
    Trading greenhouse gas (GHG) reductions at both $5/t carbon and $14/t carbon,
    Trading nitrogen reductions to meet either a 3 or 8 mg/l/day N discharge limit for wastewater
                                                                                    3

        treatment facilities,
    Trading phosphorus reductions to meet either 1 or <1 mg/l/day P discharge limit for wastewater
                                                                                    4

        treatment facilities, and
    Trading nitrogen reductions (to meet 3mg/l/day N discharge limit for wastewater treatment
        facilities) with an additional payment for the associated GHG reductions achieved with any
        implemented BMP.

These policies were evaluated using an agro-environmental model of U.S. agriculture, the U.S. Regional
Agricultural Sector Model (USMP). This model was developed and is maintained by the U.S. Department
of Agriculture/Economic Research Service (USDA/ERS). WRI has worked with USDA/ERS to improve
the spatial delineation of USMP, increase the diversity of cropping rotations included in the model, and
simulate the environmental impacts of various cropping production practices and the Conservation
Reserve Program.

Only a short synopsis of the results of this study is outlined in this paper. A more detailed explanation of
the findings and recommendations of this study and description of the model used can be found in
Greenhalgh and Sauer (2003).

Taking a broader look at the environmental impacts of the various policy options, nutrient trading
performed better than the other options assessed (Figures 1a through 1f). Nutrient trading provided the
largest decreases in nitrogen reaching the Gulf of Mexico and the greatest improvements in farm income.
In addition, nutrient trading demonstrated improvements in local water quality as well as reductions in
GHG emissions and soil losses. Other policy options performed well for some environmental parameters
but not for others. For instance, conservation tillage subsidies gave the largest reductions in soil loss and
reasonable reductions in nitrogen delivered to the Gulf of Mexico, but resulted in decreases in farm
income. This decrease comes from an increase in farm acreage which led to increased crop production,
and a subsequent decline in crop prices.

The other important aspect of assessing different policy options is how cost-effective they are at meeting
the goal of interest, in this case reducing the amount of nitrogen reaching the Gulf of Mexico from the
Mississippi River Basin. In other words, which policy gives the „biggest bang for your buck.‟ The lowest-
cost mechanisms in our study were the performance-based options, such as nutrient and GHG trading
(Figure 2). However, the most cost-effective solutions were the options based on nutrient trading, which
achieved large reductions in the amount of nitrogen delivered to the Gulf of Mexico at low prices.

3
  These discharge limits are based on the limits the Chesapeake Bay are discussing to deal with their nitrogen
pollution problem.
4
  The 1 mg/l/day discharge limit represents a transition point in technology and capital expenditure for phosphorus
removal.




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Our conclusion at the end of this study was that nutrient trading was indeed a worthwhile policy solution
for helping meet water quality targets, and for providing other environmental benefits.

Analysis of phosphorous water quality impairments

Similarly, in an analysis of policy options to improve phosphorous impaired waters in Wisconsin,
Michigan and Minnesota, performance-based mechanisms were the most cost-effective (Faeth, 2000).

This study tested four policy options:
     A point source performance standard where point sources had to meet more stringent regulatory
        requirements
     Conventional agricultural subsidies for mulch tillage, no-till and nutrient management
     A point source performance requirement coupled with trading which allowed point sources to
        trade with other point and non-point sources to meet the new regulatory requirement.
     A trading program coupled with performance-based conservation subsidies where point sources
        and non-point sources shared the nutrient reduction obligations, and non-point sources were
        allowed to meet their obligation using their least-cost option rather than the adoption of a
        particular BMP.

In all three watersheds, tightening the point source regulatory requirements was the most expensive option,
and a trading program coupled with performance-based conservation subsidies was the least-cost option
(Table 1).

Table 1. Cost of phosphorus control under different policy options

   U.S. $/pound        Point Source    Conventional       Point Source       Trading           Least-Cost
    P removed          Performance     agricultural       Performance      Program with         Solution
                        Standard        Subsidies        Standard with     performance-
Case                                                        Trading            Based
Study                                                                      Conservation
Watersheds                                                                   Subsidies
Minnesota River,
                          19.57            16.29              6.84              4.45               4.36
Minnesota
Saginaw Bay,
                          23.89             5.76              4.04              2.90               1.75
Michigan
Rock River,
                          10.38             9.53              5.95              3.82               3.22
Wisconsin
Source: Faeth, 2000.

Giving point sources the flexibility to meet their performance requirements by either upgrading their
facilities or by trading with other point sources or non-point sources considerably lowers the cost of
meeting regulatory requirements. Figure 3 illustrates the costs associated with achieving different levels of
phosphorous reductions for the Michigan case study.




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Challenges to Implementing Nutrient Trading

Based on the comparative assessment of various policy options for improving water quality, nutrient
trading emerged as the most cost-effective solution. However, while the concept of water quality trading
has found favour with many in the environmental, agricultural and policymaking communities, the
application of water quality trading has achieved only limited success in the few watersheds where it has
been applied. Water quality trading faces some unique challenges given that it includes both regulated and
unregulated sources, must address nutrient fate and transport, and must be able to quantify reductions from
non-point sources that are not directly measurable. Outlined below are some of the challenges and issues
that face organisations or government agencies in implementing nutrient trading programs.

Establishing the rules

There are a number of issues that need to be considered when establishing the rules of a trading program.
Some of these issues are briefly discussed below.

Market design
The design of the market for trading programs is important for establishing who can trade, how the trading
mechanism would work, and the rules that would sanction a trade. Trading programs can be designed in a
number of different ways including:
   Traditional market structures where individual regulated sources (e.g., point sources) can purchase
      credits from non-regulated (e.g., many non-point sources) or other regulated sources to meet their
      compliance obligations. The Dillon Reservoir and Cherry Creek trading programs in Colorado, U.S.
      are examples of these markets.
   A market where an aggregate cap is established for regulated sources and trading with sources
      outside of the cap is allowed for compliance purposes. The Tar-Pamlico and Long Island Sound
      trading programs in the U.S. are characterized as being this type of market structure.
   Using a bank to aggregate credits from non-regulated sources. Reductions from non-regulated
      sources are often small compared to the reductions needed by the regulated sources. A bank can
      serve three roles—to bundle credits into larger trading lots, potentially reduce the liability for these
      small sources (see liability discussion below), and to help stimulate markets that are not yet fully
      functioning. This structure is being discussed widely in the U.S. as a way to more successfully
      incorporate non-point agricultural sources into these trading markets. The South Nation trading
      program in Ontario, Canada is structured similar to a bank model. Regulated dischargers purchase
      phosphorous reduction credits from South Nation Conservation (SNC), a community-based
      watershed organization. In turn, the SNC uses this money to pay farmers to reduce phosphorus
      through implementation of BMPs.

Ensuring fungibility
Because non-point source nutrient reductions are difficult to measure and quantify, there is real concern in
any nutrient trading program about the fungibility of credits: how does a trading program quantify non-
point source reductions and ensure that a credit from a non-point source is equal to that of a point source?

Most of these fungibility concerns are addressed through the use of discount factors. For instance,




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1) The uncertainties involved with non-point source reductions can be addressed through the
   establishment of sound and consistent estimation tools. Using the same method to calculate all non-
   point source reductions will ensure that they are all comparable (see NutrientNet discussion below).
   Uncertainties within the estimation method itself can then be addressed through the application of
   trading ratios. Trading ratios are discount factors related to the uncertainty associated with the actual
   measurement of reductions, e.g., the uncertainty associated with the effectiveness of an agricultural
   BMP in achieving nutrient reductions. Applying a 2:1 trading ratio means that a point source whose
   nutrient discharge is known with certainty has to purchase two units of nutrient reduction from a non-
   point source whose actual achieved reduction is more uncertain for every unit of reduction they
   require.
2) Another factor with credit fungibility is the variability in nutrient fate and transport depending on the
   location of the source within the basin. Nutrient trading programs can be designed to address the
   variability in nutrient delivery by using location-specific attenuation factors or spatial delivery ratios.
   For non-point sources this means estimating the delivery of nutrients from the source to the stream as
   well as the attenuation of the nutrient from where it enters the stream to the point of interest within the
   watershed. Spatial delivery ratios are frequently determined from existing bio-physical models. For
   instance, the Revised Soil Loss Equation (RUSLE) (Renard et al., 1991) estimates nutrient loss to the
   edge of a farm field for sediment-bound phosphorus. Other models, e.g., SEDMOD (Fraser et al.,
   1996), can then be used to assess how much of the sediment-bound phosphorus reaches the nearest
   water body. Similarly, nitrogen models such as the Chesapeake Bay Model (Cerco et al., 2002)
   provide estimates for both the attenuation of nitrogen within river segments and from various river
   segments to different points of interest within a watershed.
3) Some nutrient trading programs allow trading between pollutants. An equivalence ratio, which refers
   to how much of one pollutant should be reduced compared to another, can be used in these situations.
   For example, in Minnesota a trading permit requires eight units of phosphorus to be reduced for every
   unit of BOD discharged.

Establishing baselines
Baselines are important for ensuring the integrity of nutrient trading programs. Similar to the concept of
„additionality‟ in the GHG trading world, baselines are established to prohibit unregulated sources from
selling reductions from management practices that are already required or have already been implemented.
To avoid the difficulties associated with operationalising the concept of additionality in the GHG world,
baselines should be set by the trading program. In many instances, non-point source baselines are a
minimum set of baseline practices, e.g., a nutrient management plan, which must be in place before the
non-point source can generate reductions to sell. Establishing a required set of baseline practices for non-
point sources ensures that “bad actors” are not rewarded for their ability to generate low-cost reductions by
implementing basic good steward practices that should have been implemented in the first place. Baselines
for point sources are typically straightforward as they usually have permitted nutrient discharge limits that
can form the baseline.

Who holds compliance liability
Liability issues—who holds liability and how liability is determined—often pose significant challenges to
the implementation of nutrient trading programs. Liability for credit malfeasance could potentially rest
with either the buyer or the seller of credits. What frequently occurs with buyer liability is that it fails to
foster market development. If a buyer cannot be assured that the purchased credits are viable reductions, it




                                                      9
is difficult for the buyer to effectively manage the cost of their exposure, making them more unlikely to
participate in a trading program. Therefore, seller liability is often an important element to achieving well-
functioning environmental commodity markets. Small sources wishing to sell reductions, however, may
find this a deterrent to participating in nutrient trading markets.

One approach to addressing liability issues is using a bank to aggregate non-point source credits. Credit
buyers purchase credits from the bank, who in turn guarantee the creditworthiness of the credit. The bank
is responsible for ensuring that non-point sources comply with their contracts and providing the agreed-
upon reductions. The bank may also keep a „credit reserve‟ to mitigate any risk of non-point sources
failing to implement a BMP or when a BMP fails to function properly.

Stakeholder engagement
One of the often overlooked components of nutrient trading programs is stakeholder engagement during
the establishment phase. As there is still some skepticism surrounding nutrient trading programs, this
raises the importance of including stakeholders in the formation and rule discussions of these programs.
Early stakeholder engagement will help create trust between potential buyers and sellers, and the
administrators of the trading program; and help promote an active trading program.

Providing the infrastructure

A successful water quality trading program needs to provide the appropriate infrastructure. Some basic
infrastructure elements for water quality trading programs include:

1) An administrative agency (or agencies) to manage the program, certify reductions and trades, and
   monitor compliance. A water quality trading program which involves unregulated agricultural non-
   point sources may face several logistical and administrative hurdles that can be mitigated by working
   closely with the agricultural community and agricultural agencies to ensure program support.
2) A trading registry to track the nutrient reductions and trades, and facilitate compliance monitoring. A
   registry is simply a database that stores information on the entities which generate and use credits.
3) A forum where buyers and sellers can meet. Many point and non-point source trades have involved a
   single point source locating non-point sources such as farmers one by one and negotiating individual
   contracts with each farmer to provide a specified number of nutrient reductions. For example, the
   Southern Minnesota Beet Sugar Cooperative contracted with over 100 farmers to purchase
   phosphorous reductions to allow them to expand their capacity and still meet their phosphorous
   discharge limit. This process can be significantly streamlined through the establishment of a central
   marketplace that allows buyers to easily identify sellers and vice-versa.




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Evaluating success

Monitoring is an important component of any nutrient trading program and is used to assess the success of
the program. Regulated sources typically have some form of monitoring already in place as monitoring is
required to prove regulatory compliance. However, unregulated sources, commonly non-point sources, do
not have any monitoring requirements. As a proxy for the direct monitoring of non-point source nutrient
losses, the BMPs implemented to reduce nutrient losses can be monitored to ensure they are installed and
properly functioning. Similarly, water quality at the watershed level should also be monitored to determine
whether the watershed‟s water quality goal is being attained. As there is typically a lag time between
program implementation and any improvement in water quality, this should be a long-term commitment.
In many trading programs, watershed monitoring is often only cursory and ensuring BMP implementation
is frequently left to the buyers of the associated nutrient reductions.

NutrientNet: Providing a Trading Infrastructure and Facilitating Implementation

Recognizing that nutrient trading had the potential to play a significant role in meeting U.S. water quality
goals, WRI and partners from the Michigan Department of Environmental Quality started to think about
how to efficiently implement these markets. Furthermore, we recognized that nutrient trading faced a
number of obstacles that made its widespread implementation complicated, including high transaction
costs, initially thin markets, and no actual marketplace for trades to occur.

Our solution was to develop an on-line marketplace, NutrientNet (www.nutrientnet.org), to overcome
these obstacles. There are two prototype versions of NutrientNet currently available—one for phosphorus
in the Kalamazoo watershed in Michigan and the other for nitrogen in the Potomac watershed in the
Chesapeake Bay. In addition there are three other sites currently under development:
     A point-point source trading market for nitrogen in the Susquehanna watershed, Pennsylvania
     A reserve auction pilot program in the Conestoga watershed in Pennsylvania
     An updated Kalamazoo watershed market with improved BMP estimation algorithms for nutrient
        losses.

The NutrientNet site comprises two key components:

1) Standardized tools for estimating point and non-point source nutrient contributions to surface waters,
    exploring nutrient reduction options, and estimating the cost of achieving reductions.

NutrientNet currently incorporates on-line calculation tools that enable farmers and wastewater treatment
facility managers to estimate nutrient loads from their operations and the cost of reducing nutrient loads
through various mitigation options. The rules for converting reductions into tradable credits are also
incorporated into the calculation tools. This includes the discount factors used to ensure fungibility, such
as trading ratios, spatial delivery ratios, equivalence ratios and retirement ratios.

The NutrientNet estimation tool utilizes a Geographical Information System (GIS) interface that allows the
users to identify the geographical location of their operation. The GIS interface retrieves the relevant
information for each type of discharge from a geographic database to estimate phosphorus and nitrogen




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loads. The types of GIS information used include aerial photographs delineating roads, streams and
landuses, distance to streams, topography and soil type.

In addition to the geographical data, NutrientNet requires specific information relevant to each operation to
estimate nutrient loads. For point sources users provide information about their specific facility, such as
current flow rates, nutrient concentration and regulatory nutrient discharge limits. Using the total annual
permitted load as a baseline, NutrientNet calculates the total credits needed for compliance (for those who
exceed their regulatory limit), or the total credits generated (for those who are under their regulatory limit).
Generated credits are calculated by subtracting the actual load from the baseline limit and applying the
appropriate attenuation factor or spatial delivery ratio.

For non-point sources, users provide information on their location, field area and physical characteristics
(e.g., slope), phosphorus content in the soil (when calculating phosphorus reductions), current and
previous crops, current tillage practices, and currently installed BMPs. With this information plus the
underlying GIS information, NutrientNet estimates phosphorus or nitrogen loads based on a series of
algorithms.5 NutrientNet provides users with nutrient loads from their particular farm, the effectiveness of
various mitigation options available to reduce nutrient losses, the cost of implementing these options on
their farm, and number of credits available to sell (based on the rules of the nutrient trading program).

2) A marketplace where potential trading partners can meet and enact trades.

NutrientNet's market section provides a virtual marketplace for users to contact buyers or sellers and post
their offers. Information about who is selling or buying credits is listed, as well as a means for potential
traders to contact each other.

NutrientNet can also be modified to accommodate a reverse auction. For example, in the Conestoga
watershed of Pennsylvania, NutrientNet was used to conduct a reverse auction for farmers in Lancaster
County. Farmers used NutrientNet‟s online estimation tool to estimate their phosphorous reductions
associated with implementing certain BMPs. The farmer then bid a price he was willing to accept to
implement a specific BMP. The market section of NutrientNet was modified to rank farmer‟s bids from
most cost-effective to the least cost-effective in terms of dollars per unit of phosphorous reduced (instead
of ranking bids based on total BMP implementation cost). A purchasing committee reviewed bids on-line,
issuing contracts to the lowest bidders until the earmarked money was exhausted.

One unique advantage to an online estimation tool and marketplace is the ability for such a system to
interface with a trading registry. A tool like NutrientNet can allow for the automated update of a registry
with records of credit generation and credit purchases. Once a user has estimated their nutrient reductions,
they may submit a notice to the registry electronically where it would be reviewed and approved by the

5
 Phosphorus losses are calculated using the Revised Universal Soil Loss Equation (RUSLE) to estimate losses to the
edge of the field (Renard et al., 1991) and the Spatially Explicit Delivery Model (SEDMOD) to estimate how much is
delivered to the stream (Fraser et al., 1996). Nitrogen losses (for the Chesapeake Bay) are calculated using the
Nutrient Management Yardstick to estimate losses to the edge of the field (IATP, 1999) and the U.S.EPA
Chesapeake Bay Program‟s Chesapeake Bay Model to estimate how much is delivered to the stream (Cerco et al.,
2002).




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administering agency. Likewise, once a trade is completed using NutrientNet, the parties to the trade could
electronically submit a notice of the trade to the registry which in turn could be reviewed and approved by
the administering agency.

Our Final Word

With the traditional policy instruments struggling to achieve environmental targets or becoming
increasingly costly solutions to our water quality problems, performance-based instruments such as
nutrient trading are becoming increasingly attractive instruments to use. Many studies have pointed to the
use of performance-based mechanisms as cost-effective solutions to water quality problems (Faeth, 2000;
Faeth and Greenhalgh, 2000; Greenhalgh and Sauer 2003). As an adjunct to regulatory policy, nutrient
trading provides the flexibility for regulated sources to achieve their regulatory requirements more cost-
effectively, while achieving overall water quality improvements.

In the U.S., these instruments are gaining popularity. Currently there are approximately 40 trading
initiatives involving 17 states and one regional effort, and six statewide trading policies and programs in
existence. There are a further 27 proposed trading initiatives under development (Breetz et al., 2004). The
release of the USEPA Water Quality Trading Policy in January 2003 has also provided certainty to many
regions and states that would like to use trading to achieve water quality targets that these reductions will
be recognized, spurring even greater interest in nutrient markets.

The often overlooked beauty of these instruments is the synergistic benefits for other environmental
problems. For instance, a nutrient trading policy for nitrogen aimed at reducing the size of the hypoxic
zone in the Gulf of Mexico also leads to improvements in local water quality, reductions in GHG
emissions and reductions in soil loss. Policies that address a diversity of environmental issues are
becoming increasingly attractive in many areas that are facing a myriad of environmental concerns. This
awareness, tied with the evolution of on-line nutrient trading markets like NutrientNet will help pave the
way for a new era that focuses on performance-based instruments to meet environmental goals.


References

Association of Metropolitan Sewage Agencies and the Water Environment Federation (1999). The Cost
of Clean. Alexandria, VA: Water Environment Federation.

Breetz, H.L., Fisher-Vanden, K., Garzon, L., Jacobs, H., Kroetz, K., Terry, R. (2004). Water Quality
Trading and Offset Initiatives in the U.S.: A Comprehensive Survey. Hanover, NH: Dartmouth College.

Carpenter, S.R., N.F. Caraco, D.L. Correll, R.W. Howarth, A.N. Sharpley and V.H. Smith (1998).
Nonpoint Pollution of Surface Waters with Phosphorus and Nitrogen, Issues in Ecology. Washington,
DC: Ecology Society of America.

Cerco, C.F., B.H. Johnson and H.V. Wang (2002). Tributary Refinements to the Chesapeake Bay Model
(ERDC TR-02-4). Vicksburg, MS: U.S. Army Engineering Research and Development Center.




                                                     13
Dunne, Mike (2002). “Coastal „crisis‟ grows: Annual dead zone largest to date.” Baton Rouge Advocate,
July 29, 2002.

Faeth, Paul (2000). Fertile Ground: Nutrient Trading’s Potential to Cost-Effectively Improve Water
Quality. Washington, DC: World Resources Institute.
<http://sustag.wri.org/pubs_description.cfm?PubID=2690>.

Faeth, Paul, and Greenhalgh, Suzie (2000). A Climate and Environmental Strategy for U.S. Agriculture.
Washington, DC: World Resources Institute. <http://sustag.wri.org/pubs_description.cfm?PubID=3051>.

Fraser, Robert H., Paul K. Barten and C. Dana Tomlin (1996). “SEDMOD: A GIS-Based Method for
Estimating Distributed Sediment Delivery Ratios.” GIS and Water Resources. September 1996.

Goolsby, Donald A.; Battaglin, W.A.; Lawrence, G.B.; Artz, R.S.; Aulenbach, B.T.; Hooper, R.P.;
Keeney, D.R.; and Stensland, G.J. (1999). Flux and Sources of Nutrients in the Mississippi-Atchafalya
River Basin: Topic 3 Report for the Integrated Assessment of Hypoxia in the Gulf of Mexico. Silver
Spring, MD: NOAA Coastal Ocean Program Decision Analysis Series No. 17 NOAA Coastal Ocean
Program.

Greenhalgh, Suzie and Sauer, Amanda (2003). Awakening the Dead Zone: An Investment for Agriculture,
Water Quality and Climate Change. Washington, DC: The World Resources Institute.
<http://sustag.wri.org/pubs_description.cfm?PubID=3803>

Institute for Agriculture and Trade Policy (1999). Nutrient Management Yardstick: A tool for promoting
on-farm efficiency and environmental protection. Minneapolis, MN: Institute for Agricultural and Trade
Policy.<http://www.iatp.org/enviroag/projects_previous.cfm#nutrientyardstick>

LUMCON (2002). Press release, July 26, 2002.

O‟Riordan ,Timothy (1997). Ecotaxation. UK: Earthscan Publications.

Rabalais, Nancy N.; Turner, R.E.; Justić, D.; Dortch, Q.; and Wiseman, William J. Jr. (1999).
Characterization of Hypoxia: Topic 1 Report for the Integrated Assessment of Hypoxia in the Gulf of
Mexico. Silver Spring, MD: NOAA Coastal Ocean Program Decision Analysis Series No. 15 NOAA
Coastal Ocean Program.

Renard, Kenneth G., George R. Foster, Glenn A. Weesies and Jeffrey P. Porter (1991). RUSLE: Revised
universal soil loss equation. Journal of Soil and Water Conservation 46(1):30-33.

U.S. Environmental Protection Agency (2002). National Water Quality Inventory: 2000 Report (EPA 841-
R-02-001). Washington, DC: Office of Water, USEPA.




                                                 14
                          Figure 1: Impact of various policy options on the environment and farm income.
                          Source: Greenhalgh and Sauer, 2003

                                                                                                    a) Nitrogen delivered to the Gulf of Mexico                                                                                                                                                                             b) Farm Income
                                                                                                                                                                                                                                                                                                                                                                                                             N Trading
                                                                       0                                                                                                                                                                                          6                                                                                                                                          with GHG
                                                                                                                                                                                                                                                                                                                                                                N Trading
                                                                                                                                                                                                                                                                                                                                                                                                             payments
                                                                                                                             GHG                                                                                                                                                                                                                                Scenario 2
                                                                                                                                                                                                                                                                  5
                                                                                                                            Trading
                                                                       -2                                    CRP            ($5/t C)
                                                                                                                                                                                                                                                                                                                                                                                             P Trading
                                                                                                           Extension                        GHG                                                                                                                   4
                                                                                                                                                                                                                                                                                                                                                                                             Scenario 2
                                                                                                                                           Trading                                                                                                                                                                                                N Trading
                                                                                                                                                                                                                                                                                                                                                  Scenario 1                   P Trading
                              Change in N delivered to Gulf (%)




                                                                                                                                          ($14/t C)                                                                                                               3




                                                                                                                                                                                                                                     Change in Farm Income (%)
                                                                              N Fertilizer                                                                                                                                                                                                                                                                                     Scenario 1
                                                                       -4
                                                                                 Tax                                                                                            P Trading                                                                                                                 CRP                           GHG
                                                                                                                                                                                Scenario 1                                                                        2
                                                                                                                                                                                                                                                                                                        Extension                      Trading
                                                                                           Conservation                                                                                                                                                                                                                  GHG
                                                                                                                                                                                                                                                                                                                                      ($14/t C)
                                                                                             Tillage                                                  N Trading                                                                                                   1                      Conservatio                    Trading
                                                                       -6
                                                                                             Subsidy                                                  Scenario 1                             P Trading                                                                    N fertilizer        n                         ($5/t C)
                                                                                                                                                                                             Scenario 2                                                                      Tax           Tillage
                                                                                                                                                                                                                                                                  0                       Subsidy

                                                                       -8
                                                                                                                                                                                                                                                                 -1


                                                                                                                                                                                                                                                                 -2
                                                                  -10
                                                                              N Trading Scenario 1: 8 mg/l N discharge limit for WWTP at $2/lb N                                                                                                                                                                                                      N Trading Scenario 1: 8 mg/l N discharge limit for WWTP at $2/lb N
                                                                              N Trading Scenario 2: 3 mg/l N discharge limit for WWTP at $5/lb N                                                                                                                 -3                                                                                   N Trading Scenario 2: 3 mg/l N discharge limit for WWTP at $5/lb N
                                                                                                                                                                   N Trading                              N Trading                                                                                                                                   P Trading Scenario 1: 1 mg/l P discharge limit for WWTP at $5/lb P
                                                                              P Trading Scenario 1: 1 mg/l P discharge limit for WWTP at $5/lb P
                                                                              P Trading Scenario 2: <1 mg/l P discharge limit for WWTP at $7/lb P                  Scenario 2                             with GHG                                                                                                                                    P Trading Scenario 2: <1 mg/l P discharge limit for WWTP at $7/lb P
                                                                  -12                                                                                                                                     Payments                                               -4



                                                                                                                c) Greenhouse Gas Emissions                                                                                                                                                                   d) Nitrogen lost to waterways
                                                                  2                                                                                                                                                                                              0
                                                                                                                           GHG             GHG                                                             N Trading
                                                                            N Fertilizer                    CRP           Trading         Trading N Trading N Trading           P Trading P Trading        with GHG                                                                                                     GHG
                                                                               Tax                        Extension       ($5/t C)                                                                                                                               -1
                                                                  0                                                                      ($14/t C) Scenario 1 Scenario 2        Scenario 1 Scenario 2      Payments                                                                                                    Trading
                                                                                                                                                                                                                                                                                                                       ($5/t C)
                                                                                        Conservation
                                                                                                                                                                                                                                                                 -2                                      CRP
                                                                                          Tillage
                                                                                                                                                                                                                                                                                                       Extension                       GHG
                                                                                          Subsidy
Change in GHG Emissions (%)




                                                                                                                                                                                                                       Change in N Lost to Water (%)




                                                                  -2                                                                                                                                                                                                                                                                  Trading
                                                                                                                                                                                                                                                                 -3                                                                  ($14/t C)
                                                                                                                                                                                                                                                                                                                                                                               P Trading
                                                                                                                                                                                                                                                                                                                                                                               Scenario 1
                                                                  -4                                                                                                                                                                                                                 Conservation
                                                                                                                                                                                                                                                                 -4
                                                                                                                                                                                                                                                                                       Tillage                                                    N Trading
                                                                                                                                                                                                                                                                          N Fertilizer Subsidy                                                    Scenario 1
                                                                                                                                                                                                                                                                             Tax                                                                                                             P Trading
                                                                                                                                                                                                                                                                 -5                                                                                                                          Scenario 2
                                                                  -6

                                                                                                                                                                                                                                                                 -6

                                                                  -8
                                                                            N Trading Scenario 1: 8 mg/l N discharge limit for WWTP at $2/lb N                                                                                                                   -7       N Trading Scenario 1: 8 mg/l N discharge limit for WWTP at $2/lb N                                                    N Trading
                                                                            N Trading Scenario 2: 3 mg/l N discharge limit for WWTP at $5/lb N                                                                                                                                                                                                       N Trading
                                                                                                                                                                                                                                                                          N Trading Scenario 2: 3 mg/l N discharge limit for WWTP at $5/lb N
                                                                            P Trading Scenario 1: 1 mg/l P discharge limit for WWTP at $5/lb P                                                                                                                                                                                                                                                  with GHG
                                                                                                                                                                                                                                                                          P Trading Scenario 1: 1 mg/l P discharge limit for WWTP at $5/lb P         Scenario 2
                                                                            P Trading Scenario 2: <1 mg/l P discharge limit for WWTP at $7/lb P                                                                                                                                                                                                                                                 Payments
                                                -10                                                                                                                                                                                                              -8       P Trading Scenario 2: <1 mg/l P discharge limit for WWTP at $7/lb P




                                                                                                          e) Phosphorus lost to waterways                                                                                                                                                                                      f) Soil erosion

                                                              0                                                                                                                                                                                                       0
                                                                                                                                                                                                                                                                                                                         GHG
                                                                                                                        GHG                                                                                                                                                                                             Trading
                                                   -1                                                                                                                                                                                                                                                                                   GHG
                                                                                                                       Trading                                                                                                                                                                                          ($5/t C)
                                                                                                                                                                                                                                                                  -2                                       CRP                         Trading
                                                                                                                       ($5/t C)
                                                                                                                                                                                                                                                                            N Fertilizer                 Extension                    ($14/t C)
                                                   -2                                                                                 GHG                                                                                                                                                                                                          N Trading
                                                                                                                                                                                                                                                                               Tax                                                                                              P Trading
                                                                                  CRP                                               Trading                                                                                                                                                                                                        Scenario 1                   Scenario 1
    Change in P Lost to Water (%)




                                                                   Conservation Extension                                          ($14/t CC)                                                                                                                     -4
                                                      N Fertilizer   Tillage
                                                                                                                                                                                                                            Change in Erosion (%)




                                                   -3                                                                                                                                                                                                                                                                                                                                         P Trading
                                                         Tax         Subsidy                                                                                                                                                                                                                                                                                      N Trading                   Scenario 2 N Trading
                                                                                                                                                N Trading                                                                                                                                                                                                         Scenario 2                             with GHG
                                                   -4                                                                                           Scenario 1                                                                                                        -6                                                                                                                                     Payments
                                                                                                                                                                          P Trading
                                                                                                                                                                          Scenario 1
                                                   -5
                                                                                                                                                                                                                                                                  -8

                                                   -6
                                                                                                                                                                                       P Trading
                                                                                                                                                                                       Scenario 2
                                                                                                                                                                                                                                                                 -10
                                                   -7                                                                                                                                                                                                                                                                                             N Trading Scenario 1: 8 mg/l N discharge limit for WWTP at $2/lb N
                                                                        N Trading Scenario 1: 8 mg/l N discharge limit for WWTP at $2/lb N                                                          N Trading
                                                                        N Trading Scenario 2: 3 mg/l N discharge limit for WWTP at $5/lb N
                                                                                                                                                             N Trading                                                                                                                   Conservation                                             N Trading Scenario 2: 3 mg/l N discharge limit for WWTP at $5/lb N
                                                                                                                                                             Scenario 2                             with GHG                                                                                                                                      P Trading Scenario 1: 1 mg/l P discharge limit for WWTP at $5/lb P
                                                                        P Trading Scenario 1: 1 mg/l P discharge limit for WWTP at $5/lb P                                                                                                                                                 Tillage
                                                                        P Trading Scenario 2: <1 mg/l P discharge limit for WWTP at $7/lb P
                                                                                                                                                                                                    Payments                                                                                                                                      P Trading Scenario 2: <1 mg/l P discharge limit for WWTP at $7/lb P
                                                   -8                                                                                                                                                                                                            -12                       Subsidy




                                                                                                                                                                                                                 15
Figure 2: Cost-effectiveness of policy options tested at reducing the amount of nitrogen delivered to
the Gulf of Mexico.


                                              25.00                                                                                                                               500

                                                                                                                                                                                  450

                                              20.00                                                                                                                               400
        Cost of N reductions to Gulf ($/lb)




                                                                                                                                                                                  350




                                                                                                                                                                                        N reductions to Gulf (m lbs)
                                              15.00                                                                                                                               300

                                                                                                                                                                                  250

                                              10.00                                                                                                                               200

                                                                                                                                                                                  150

                                               5.00                                                                                                                               100

                                                                                                                                                                                  50

                                               0.00                                                                                                                               0
                                                                                                                                                                      N Trading
                                                                        N fert tax Cons Till CRP Ext.    GHG       GHG    N Trading N Trading P Trading P Trading with GHG
                                                                                     Sub                Trading   Trading Scenario 1 Scenario 2 Scenario 1 Scenario 2 payments
                                                                                                         ($5/t)   ($14/t)

                                                                                                                  Cost   N Reduction

Source: Greenhalgh and Sauer, 2003

Figure 3. Cost-effective of nutrient trading: Michigan case study for phosphorus (in U.S. dollars)



                                                                                                  regulatory
                                                                                                  requirement                               Conventional
                                                                        160                                                                 Conservation Subsidies
                                               Cost per P Removed ($)




                                                                        120



                                                                         80                          Point Source
                                                                                                     Regulation

                                                                         40                                                                  PS Regulations
                                                                                                                                             with Trading


                                                                          0
                                                                               10       15      20        25       30       35         40     45       50       55        60           65

                                                                                                        % Reduction in P Load
Source: Faeth, 2000.




                                                                                                                             16

								
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